The European Insurance and Occupational Pensions Authority (EIOPA) published today a report analyzing how insurance undertakings in the EU implemented the new insurance accounting standard IFRS 17 as well as the synergies and differences in the calculation of insurance liabilities with the Solvency II framework.
In January 2023, IFRS 17 became the new international accounting standard for insurance contracts, replacing the previous interim standard, IFRS 4. The objective of this transition is to enhance reliability and transparency in financial statements and reduce methodological differences through harmonization. The report is based on 2023 semiannual financial statements from a sample of 53 (re)insurance groups from 17 Member States.
Impact
The move to IFRS 17 led to significant changes in the value of insurance liabilities given the use of different valuation approaches, the shift from implicit prudency to explicit risk adjustment and the introduction of a contractual service margin (CSM) in IFRS 17. The CSM reflects the expected profit at inception and allows insurers to allocate expected profits over the lifetime of an insurance contract as insurance service is provided. Data from respondents show that although the introduction of IFRS 17 had varied impacts, it generally resulted in an increase of insurance liabilities and a consequent decrease in shareholders’ equity.
IFRS 17 offers insurers three transition approaches and three distinct valuation methods. Regarding the transition, all three approaches (full-retrospective approach, modified retrospective approach and fair value approach) have been used to a similar extent, with the fair value approaches being the most frequently chosen option accounting for 42% of insurance liabilities. When it comes to valuation methods, EIOPA observed a clear link with the type of the insurance contract. Insurers in the sample valued 86% of their life insurance liabilities using the variable free approach (VFA), while non-life insurance contracts were mostly (90%) valued using the premium allocation approach (PAA). The general model was chosen for the remaining liabilities.
Differences between IFRS 17 and Solvency II
Although Solvency II and IFRS 17 serve different purposes – the former aims to protect policyholders while the latter focuses on providing reliable information to the users’ of undertakings’ financial statements – they share significant similarities allowing for material synergies. These include, for example, employing a market-consistent valuation approach, probability-weighted estimates of future cashflows, and discount rates to determine the present value of cashflows expected from the insurance liabilities.
However, the two frameworks also differ from one another in important ways. Major differences lie in the valuation methods permitted by IFRS 17 and the inclusion of a Contractual Service Margin, while other relevant differences exist in the discount rates, risk adjustment/margin, contract boundaries and the allocation of expenses.
Regarding quantitative differences, under IFRS 17, life insurance liabilities (excluding CSM) were on average 2.5% lower than the corresponding Solvency II technical provisions. For non-life insurance contracts, however, IFRS 17 insurance liabilities (excluding CSM, except for contracts under the PAA) are, on average, 9.5% higher than in Solvency II.
In terms of discount rates, while Solvency II prescribes the risk-free interest rate term structures (RFR) calculated and published by EIOPA, under IFRS 17 insurers are responsible for deriving the risk-free rate themselves. Nevertheless, EIOPA’s research shows that in practice 75% of the insurers surveyed rely on EIOPA’s RFR for their IFRS 17 calculations. Still, the final discount rate in IFRS 17 was often higher than in Solvency II due to illiquidity adjustments allowed in IFRS 17.
Another source of difference is the calculation method and the confidence level for the risk margin. For life business, the risk adjustment under IFRS 17 is significantly lower than the Solvency II risk margin. Conversely, for non-life business, the risk adjustment under IFRS 17 is slightly higher.